How to Use Mixed Bundling to Increase Profits
A strategy observed by managerial economists that increases profits for business is mixed bundling. Mixed bundling allows customers to purchase the goods either together as a bundle or separately. One of the crucial differences between mixed bundling and pure bundling is that some customers purchase only a single item.
These customers have a reservation price greater than the actual price for one item. However, they don’t buy the bundle because the difference between the bundle price and the price of the first item is less than their reservation price for the second item.
For example, say you’re willing to pay $30.00 for Software W and only $2.00 for Software X. In addition, the price of Software W separately is $20.00, the price of Software X separately is $15.00, and the price of the bundle is $24.00.
Obviously, you’re willing to buy Software W separately — its $20.00 price is less than your reservation price of $30.00. Similarly, you’re not willing to buy Software X separately because its $15.00 price is greater than your reservation price of $2.00.
In a surprising result, you’re not willing to buy the bundle. To move from buying Software W for $20.00 to buying the bundle requires you to pay $24.00. This is $4.00 more than you have to pay to purchase Software W alone. Because your reservation price for Software X is only $2.00, it’s not worth spending the extra $4.00 to buy the bundle. The point labeled U represents this situation.
In order for you to purchase the bundle, the difference between the separate price for the first item and the bundle price must be less than your reservation price for the second item.
Now assume that your reservation price for Software W remains $30.00, but your reservation price for Software X is $7.00. In this situation you’ll buy the bundle because you’re willing to pay $30.00 for Software W. That’s higher than Software W’s actual price. You can then add Software X for another $4.00 because the price of the bundle is $24.00.
Instead of purchasing Software W alone for $20.00, you can purchase the bundle including both Software W and Software X for $24.00. Because Software X is worth $7.00 to you, adding Software X to the bundle is worth it to you. You get something you’re willing to pay $7.00 for and it costs you only an extra $4.00.
In the illustration, the vertical shaded area represents customers who buy only Software W. Note for this shaded area, customers’ reservation prices for Software W are higher than Software W’s $20.00 price. However, their reservation prices for Software X are less than $4.00. Because adding Software X to the bundle costs $4.00, they’re not willing to buy the bundle.
The horizontal shaded area represents customers who buy only Software X. In this horizontal shaded area, customers’ reservation prices for Software X are higher than its $15.00 price. If these customers add Software W to the bundle, it increases the price by $9.00 to $24.00.
For this group of customers, their reservation prices for Software W are less than $9.00; so, they’re not willing to add Software W to their purchase of Software X.
Customers in the diagonal shaded area buy the bundle of Software W and Software X. For these customers, the reservation price of adding the second software package to the bundle is greater than the price difference. Finally, the area that isn’t shaded represents customers who don’t buy any software package.
Customers only add another good to the bundle if the actual price difference between the bundle and buying an item separately is less than the additional item’s reservation price.
Determining your total revenue with mixed bundling is very tricky. Again, assume you have 1,200 uniformly distributed customers that correspond to the area of the rectangle. Of those customers, 80 purchase just Software W at a price of $20, 135 purchase just Software X at a price of $15, and 745.5 purchase the bundle at a price of $24.
The remaining 239.5 don’t purchase any software program because the price of each individual program is higher than their reservation price for that program, and the bundle’s price is higher than the customer’s reservation prices for the two programs added together. Thus, your total revenue equals $21,517 — that is, (80 × 20) + (135 × 15) + (745.5 × 24).
Your revenue increases by $517 with mixed bundling as compared to selling each program separately.